A bond is essentially a loan to an entity, such as the government or a corporation. In return for your investment, the organization promises to return your principal at the date of maturity and to pay interest at certain intervals. A corporate bond is a bond issued by a corporation. A corporation issues bonds to raise capital for activities such as expanding operations. The term “corporate bond” is usually applied to longer-term debt instruments, generally with a maturity date falling at least a year after the date of issue. The “coupon rate” of a corporate bond fixes the amount of interest paid to the bondholder. In general, the higher the interest payment, the riskier the investment in that corporation. The interest payment on corporate bonds is usually taxable income.
Corporate bonds receive ratings from various rating agencies. These ratings indicate the level of risk, as determined by the rating agency, that the issuing corporation will not be able to meet its debt obligations. Lower rated corporate debt indicates that the corporation issuing the debt is less likely to be able to repay its bondholders and will generally offer higher interest payments to compensate the investor for the higher risk of default. Sometimes the coupon rate on a corporate bond can be zero with a redemption value greater than its price. This type of bond is called a “zero-coupon” bond. Some corporate bonds have a call option that allows the issuer to redeem the debt before its maturity date. Other bonds, known as convertible bonds, allow investors to convert the bond into equity. The vast majority of trading volume in corporate bonds takes place in decentralized, dealer-based, over-the-counter markets, as opposed to trading on an exchange.
Corporate bonds can broaden a risk profile and diversify a portfolio of equities or government bonds depending on the market conditions, the credit rating of the bond issuer, and the investor’s level of risk tolerance. In addition, corporate bonds may offer investors the potential for steady income and attractive yields. On the other hand, corporate bonds may expose investors to substantial losses in the event of a default by the issuing corporation. Careful attention should be paid to the credit quality of the bond issuer before investing in a corporate bond.
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